In May of 1991, the Department of Treasury published regulations on
deferred exchanges (TD 8346 containing Reg. §'s 1.1031(b)-2 and
1.1031(k)). These regulations set out complex rules for identifying
and receiving replacement property. They also addressed various issues
in regard to multiple asset exchanges; incidental property transfers
made as part of an exchange, and revocation of replacement property
identifications. However, the most significant provisions included in
these Regulations dealt with the establishment of 3 safe harbors.
These safe harbors provided taxpayers with a vehicle to avoid receipt
or constructive receipt of sales proceeds while securing the
taxpayers' funds and the obligation of the transferee to acquire
Safe Harbors - Reg. § 1.1031(k)-1(g) established the following 3
safe harbor arrangements:
- Security or guarantee arrangements.
- Qualified escrow or trust arrangements.
- Qualified Intermediary (QI) arrangements.
Of the three, the use of a Qualified Intermediary provides the
greatest flexibility in dealing with recurring multiple exchanges of
like kind personal property.
The Qualified Intermediary Safe Harbor
Under this safe harbor, the QI functions as the cash middle man
between the taxpayer and the buyer of relinquished property and the
taxpayer and the seller of replacement property. The workings of a
Deferred Exchange under the QI safe harbor can best be illustrated by
the following flowchart:
Exchanges of property qualify for tax deferral only to the extent
that property is exchanged solely for property of a like kind.
Regulations expressly limit the taxpayer's rights to receive, pledge,
borrow, or otherwise obtain the benefits of any sales proceeds whether
those sales proceeds are paid in the form of cash, other non-Like-Kind
property or buyer notes. In those situations where the buyer's
consideration is paid in a form other than like-kind replacement
property, sales proceeds are generally remitted directly to the QI who
then uses the value of this non-like-kind property to acquire
replacement property and otherwise accomplish the taxpayer's exchange.
This is not to say that title to property must also flow through
the QI. On the contrary, title to relinquished property may flow
directly from the taxpayer to the buyer and title for replacement
property may flow directly from the seller to the taxpayer.
Regulations only require that the taxpayer enter into a written
exchange agreement with the QI (the "Exchange Agreement") whereby the
taxpayer agrees to assign its interest in the purchase and sales
contracts to the QI and give notice of this assignment to all parties
Once sales proceeds are deposited with the QI, they can only be
used to retire outstanding debt on the property sold; pay transaction
and exchange related costs or acquire replacement property.
Accordingly, any non-like-kind property received by the QI (net of
relinquished property debt and exchange fees and expenses) must either
be reinvested in like kind replacement property or they must remain
under the QI's control for the duration of the related 45 day / 180
day exchange period.